Issuers: Pub chains
Amounts: £535 million; £231 million
Type of deal: Leveraged acquisition securitizations
Lead managers: Morgan Stanley Dean Witter; BT Alex Brown
Date of Issues: 23 February; 12 March
Coming off the phone from Lemy Gresh, BT Alex Brown's head of securitization, you could be forgiven for thinking he only did the Punch Taverns deal as an excuse to get to the pub more often. "Where's your office?" he asks. "Near Fleet Street? Great. One of our pubs is there."
On arrival, slightly late it must be said, a quiet chat has turned into a corporate event: Gresh has brought four other members of the team with him, including Youssef Khlat, managing director of the bank's European syndicate desk, and a vice president, Mark Radin, and two associates from the securitization group, Santiago Corral and Sebnem Erol. Gresh is keen to talk, and his entourage is more than happy to oblige; "It's the first time he's ever taken us out to lunch," jokes Khlat. Must be an important deal.
The week before, BT Alex Brown had lead-managed a five-tranche, £535 million securitized bond issue for this chain of 1,428 pubs, previously owned by brewing company Bass. In November last year Gresh was approached by two executives from Grovebase Properties, Hugh Osmond and Roger Myers. The former is part owner of Pizza Express, the latter holds a big stake in the Café Rouge chain, and they wanted to get into pubs.
After four months working on the deal, you'd think the bankers from Bankers could at least get a table; but no. Khlat had phoned ahead, but the law of the jungle prevailed and there were no seats left. "Well, at least it shows that we've been involved in a successful deal," muses Gresh once he sits down in an Italian restaurant in a basement across the road.
Using securitization to finance acquisitions is not unknown in Europe, but it is hardly common; and only the UK has a regulatory environment benign enough to make it worthwhile. Big deals in the past have included Nomura's securitization for the acquisition of ministry of defence property, and for Welcome Break (the latter, launched last August, was also brought by Gresh's team).
The Punch deal was not the first based on pub revenues, though; three weeks before, Morgan Stanley launched a £231 million ($390 million) deal for the acquisition of the 845-pub Wellington Group from Phoenix Inns. Again, it was Grovebase buying the pubs, with Morgan Stanley Real Estate Fund also taking a stake.
Both deals were able to capitalize on three crucial factors: First, the management of Grovebase has a successful history of working in the catering and service trade, which would appeal to investors; second, investors are crying out for deals offering yield and security; and third, says Steve Din, executive director in Morgan Stanley Dean Witter's securitization team, "fund managers in the UK are well placed to understand the role of the pub in British culture. They know it has the ability to generate cash flow, and it's always reassuring to go into one of these pubs and see the revenue coming in".
Radin on BT's syndicate desk found the same thing: "We had potential investors ringing up for lists of the Punch pubs listed by postcode. They wanted to get out and sample the estate."
Though the two deals were for the same group, they are not that similar. Both are backed by future revenue streams, but the Wellington deal has a rather more straightforward structure. For one thing, the largest of the three tranches, £160 million, is rated AAA, whereas the Punch deal, with five tranches, does not carry anything above a single-A.
"We were able to achieve this because the revenue streams used as assets on this are more stable [than in the Punch deal]," says Scott Peterson, managing director in the international securitization group at Morgan Stanley Dean Witter. "All we are using is the revenue from the leases, and all bar a dozen of the pubs have leases which last for 20 years, with upward-only rent reviews every five years." Grovebase and Morgan Stanley also had the properties valued at £240 million, the estate should be more than enough to cover any future disaster.
The other public tranche of the Wellington deal, for £51 million, is rated single-A, with the final £20 million being a private placement to a single investor. All three tranches were fixed rate, and mature in 2029.
The Punch deal was more complex. Following the template of the Welcome Break transaction last year, it is split between two fixed and three floating tranches, each maturing at a different time the first in 2008; the last in 2026. The assets for the deal are both the till receipts and the rents (the split is roughly 60:40 in favour of receipts from beer sold to the landlords), but in this case the leases do not extend beyond 10 years.
"We split the deal up into five tranches, and between fixed and floating, so that we could offer as much variety, and market the deal to as many investors as possible," says Gresh. "The floaters, with durations between 10 and 13 years, appealed to the commercial banks, and the pension funds were the main buyers of the longer-dated fixed-rate paper." And as with the Wellington deal, one tranche was tailored to meet a single investor's request, this time an £80 million floater, rated single A/A2. "This particular financial institution wanted a large chunk of the deal, and was prepared to take on the implied risk of being the last of the floating-rate tranches to be repaid."
But it is unlikely that this tranche will be held until maturity. In March 2010, one year before the £60 million floating tranche falls due, the interest payment steps up from 95 basis points over Libor to 200bp. The issuer has a call option on that paper from 2003, and is likely to exercise it. "There aren't too many single A issuers out there offering Libor plus 80," says Gresh. "But this is a strategic business move for them, not an exercise in shaving off the two basis points."
Gresh and his team, and the Morgan Stanley bankers, are confident that this will become a more important asset class. The potential savings, and increased flexibility, that a capital-markets securitization can bring to an acquisition puts it in a good position to challenge the more usual bank loan route. In the Punch deal, a bank loan would have had more stringent covenants and a shorter maturity (Gresh had allowed for 11 years), and would have had a total cost of funds of 311bp over Libor; the securitization allowed for the debt to be paid down over 28 years, at 104bp over Libor. And for 25% more debt (the bank loans would have been £430 million), the cost of capital works out at 7.9%; the bank debt route would have been 10.5%.
What better reason do you need to drink yourself silly?